THE RESTAURANT INDUSTRY – SIGNS OF LIFE, BUT CLARITY IS ELUSIVE !!
SALES HAVE BOTTOMED AND PEOPLE STILL HAVE TO EAT
The next few weeks are going to be interesting, especially relative to the mix between dine-in and off-premise revenues . Most of the major full service and fast casual chains that have remained open have seen steady sales increases (off the bottom) as customers have become comfortable with the off-premise options. Cheesecake Factory, for one, has been doing 40% of their previous sales level, even with the dining room closed. QSR chains with drive-thru capabilities have seen steady increases to the point where some chains are reporting only single digit declines most recently. Wendy’s, for example, helped by their breakfast introduction, had a 1% comp increase in Q!, sales bottomed at a negative 25.9 in the week ended 4/3, have improved steadily to a very modest 2.1% decline in the week ending 5/3. QSR chains and fast casual chains without drive-thru service are still down much more substantially. An example here is Shake Shack, with airports and destination locations, saw comps bottom at a negative 73% in the W/E 3/25 and were still down 45% in the W/E 4/29. From this point forward, there are 14 states starting to ease Covid restrictions so sales should continue to recover. How fast and how far is anybody’s guess. It will vary widely, including the sales mix as described above, and we all have to hope that Covid does not flare up widely. That’s the positive side.
THE EXPENSE SIDE OF THE INCOME STATEMENT IS ALSO UNCERTAIN
The most important expense categories: Cost of Goods Sold, Labor, Rent and Other Operating Expenses are all “up for grabs”.
Cost of Goods, consisting largely of commodities, will always vary depending on supply and demand. This expense line is in question due to potential protein shortages. Most widely publicized lately has been the meat shortage and the producers and distributors have held out hope that this is a short term situation. Wendy’s has acknowledged the shortage. McDonald’s has stated that they have no problem but they didn’t have beef for my quarter pounder with cheese yesterday.(They did give me a “double cheeseburger” which had two smaller patties (frozen, I guess), rather than fresh beef,and it was very good sandwich for $2.00. (Postscript: Had my qtr. pounder today, an excellent product !)There will hopefully be no major distortions in the commodity equation but we can’t be sure. Of course, improved packaging will be necessary to compete in the off-premise segment, and the cost of delivery will have to run through the income statement somewhere.
Labor expense is fairly certain, but moving in the wrong direction. The continuous escalation in hourly wages will not change, and could well accelerate as the politicians continue to confront the wealth gap by way of an increasing minimum wage. Additionally, the labor hours necessary to support the new hybrid operation, unlikely to be less, has yet to take shape. Furthermore, the transition period over the next three to six months, until sales have normalized, is likely to be more expensive in terms of labor. McDonald’s announced a 10% bonus for crew members in May, no doubt considered hazardous duty pay. Restaurant Brands has announced bonuses for Burger King and Popeye’s crew, no doubt also to lure back workers who are receiving more from unemployment benefits and supplements than they would normally earn working. Some workers are anxious to get back to work and protect their jobs for the long run, but others figure they can always get another job, and summer is coming, after all.
The Other Operating Expense line is also likely to accelerate. In addition to waste removal, utilities, insurance, banking fees, etc., cleaning supplies will be a lot more significant, health testing procedures will be implemented, masks and gloves will be provided.
Rent has become a negotiable variable in the new economy. Restaurants that are obviously doing well, a very small minority, will pay their rent as usual. Domino’s and Wingstop come to mind as chains that have no argument for reduced rent. Almost everybody else, especially full service casual dining chains, will have certain locations that can justify modifications of lease terms. Landlords are well aware of the situation, don’t want to lose previously valued tenants (they can’t currently replace them anyway) so some major developers have already been proactive in addressing the situation. There will be adjustments in many cases but the process will take months, and the result will be uncertain.
There will also be potential cost increases at the corporate level (G&A), and even some incremental, if modest, capex. New training procedures will be necessary to ensure new health standards, and that will be an ongoing effort since there is such high crew turnover. Restaurants will be reconfigured to some degree to accommodate the social distancing and more efficiently serve the off-premise segment. New software and hardware may be necessary for point of sale no-contact payment and other new cooking and service procedures.
SUMMARY
Putting it all together: This too shall pass, and people have to eat, but nobody knows what the new economic equation for restaurant operators will look like. Operators, in any industry, as well as investors, never know for sure what the future holds, and make their partially informed bets accordingly. Operators have no choice but to react as productively as possible as the facts unfold. From an investment standpoint, it makes the most sense to wait for the picture to clarify. The stock price may be materially higher, but the reward/risk could be much more attractive. Never more true are the immortal words of Yogi Berra: “Predictions are always difficult, especially about the future.”
Roger Lipton